Flagstar Financial Inc (NYCB) 2017 Q2 法說會逐字稿

Good morning, and thank you all for joining the management team of New York Community Bancorp for its quarterly conference call.

Today's discussion of the company's second quarter 2017 performance will be led by President and Chief Executive Officer Joseph Ficalora, together with Chief Operating Officer Robert Wann; Chief Financial Officer Thomas Cangemi and John Pinto, the company's Chief Accounting Officer.

Certain comments made on this call will contain forward-looking statements that are intended to be covered by the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

Such forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those the company currently anticipates due to a number of factors, many of which are beyond its control.

Among these factors are: general economic conditions and trends, both nationally and in the company's local market; changes in interest rates, which may affect the company's net income, prepayment income, mortgage banking income and other future cash flows or the market value of its assets, including its investment securities; changes in the demand for deposit, loan and investment products and other financial services; and changes in legislation, regulation and policies.

You will find more about the risk factors associated with the company's forward-looking statements on Page 9 of this morning's earnings release and in its SEC filings, including its 2016 annual report on Form 10-K and Form 10-Q for the quarterly period ended March 31, 2017.

The release also includes reconciliations of certain GAAP and non-GAAP financial measures that may be discussed during this conference call.

If you would like a copy of this morning's release, please call the company's Investor Relations department at (516) 683-4420 or visit ir.mynycb.com.

As a reminder, today's call is being recorded.

(Operator Instructions)

To start the discussion, I will now turn this call over to Mr. Ficalora, who will provide a brief overview of the company's second quarter 2017 performance before opening the line for Q&A.

Mr. Ficalora, please go ahead.

Thank you, Sherry, and thank you all for joining us this morning as we discuss our second quarter 2017 results.

This morning, the company reported net income of $115.3 million, up 10.9%, from the $104 million we reported in the first quarter of the year.

Net income available to common shareholders totaled $107 million or $0.22 per common share compared to $104 million or $0.21 per common share in the trailing quarter.

Our results this quarter were influenced by several recurring factors.

While prepayment income increased, our short-term interest rates resulted in a modest decline in our net interest income.

Loan originations increased at a double-digit rate compared to the first quarter.

But overall, balance sheet growth was tempered by prepayments, the sale of loan participations, our continuing selectivity on multi-family CRE credits, and our strategy to manage the balance sheet below the $50 billion SIFI threshold.

There were 2 items of note, which transpired during the second quarter.

First, on June 27, we announced the sale of our mortgage banking business, which was acquired as part of our 2009 FDIC-assisted acquisition of AmTrust Bank to Freedom Mortgage Corporation.

Freedom will acquire both our origination and our servicing platforms as well as our mortgage servicing rights portfolio with a current unpaid principal balance of approximately $21 billion.

Additionally, we received approval from the FDIC to sell the assets covered under our loss share agreement and agreed to sell the majority of our one-to-four family residential mortgage-related assets to an affiliate of Cerberus Capital Management.

We expect that both transactions will close by the end of the third quarter and result in a pretax gain on sale of $90 million.

Second, the company made a strategic decision to reclassify the entire securities portfolio as available for sale from held-to-maturity, and we took advantage of the favorable positions in the bond market to sell approximately $500 million of securities, resulting in a gain on sale of $26.9 million on a pretax basis.

This strategy improves our interest rate risk sensitivity and enhances our liquidity measures.

Additionally, as we assess when and how to cross the SIFI ceiling, it affords us greater flexibility on how to meet the LCR requirements.

On that note, I would like to reiterate our view that the best way to -- of transitioning to SIFI status remains through a large merger transaction.

We've continued to actively monitor the regulatory dialogue in Washington and are encouraged by several of the suggested proposals.

Developments in Washington notwithstanding, we expect to resume meaningful balance sheet growth during the second half of the year.

With the company's total consolidated assets averaging $48.9 billion for the 4 quarters ended June 30, 2017, we have ample opportunities to grow the balance sheet by approximately $5 billion without reaching the SIFI threshold on a trailing 4-quarter basis.

Turning now to our second quarter 2017 results.

As you read in this morning's news release, the company reported second quarter net income of a $115.3 million, up 10.9% on a linked quarter basis.

Net income available to common shareholders rose 3% from the prior quarter to $107 million or $0.22 per common share.

This translates into a 0.94% return on average assets and a 6.97% return on average stockholders' equity.

On a tangible basis, return on average tangible assets was 0.99%, and return on average tangible common stockholders' equity was 11.54%.

Focusing now on our lending.

It was a good quarter for loan production.

During the second quarter, we originated $2.4 billion of loans including $1.9 billion of loans originated for investment.

This was 12.8% higher than our total loans held for investment production during the first quarter of the year.

Multi-family loans represented $952 million of second quarter production, and CRE loans represented $192 million.

At the end of the quarter, multi-family loans totaled $26.9 billion of total loans held for investment.

CRE loans represented $7.5 billion of total loans held for investment.

We also saw a strong growth in our specialty finance business.

Specialty finance originations were $499 million, up 85% compared to the trailing quarter.

Specialty finance loans increased $182 million this quarter to $1.5 billion, up about 14% sequentially.

Our current pipeline amounts to $2.2 billion, with $1.8 billion consisting of held-for-investment loans.

Turning to asset quality.

Our quarter-end metrics were solid and continue to rank among the best in the industry.

Despite a $22 million increase in non-accrual New York City taxi medallion loans and other C&I loans secured by taxi medallions.

Specifically, nonperforming noncovered loans represented 0.22% of total noncovered loans at the end of the second quarter compared to 0.16% at March 31.

Likewise, on nonperforming noncovered assets increased 0.20% of total noncovered assets at the end of June compared to 0.15% at the end of March.

The ratio of net charge-offs to average loans was only 3 basis points despite the $11 million charge related to taxi medallions.

Most importantly, our core portfolio continues to generate 0 losses.

At June 30, the New York City taxi medallion loan portfolio totaled $134.2 million, representing a 0.36% of total held for investment loan portfolio.

Moving now to our income statement.

Our net interest income declined a modest 2.4% compared to the trailing quarter, primarily attributable to an increase in our cost of funds as short-term interest rates rose during the quarter.

The net interest margin declined 6 basis points to 2.65% on a linked quarter basis.

This is reflective of higher prepayment income, offset by higher interest expense.

Prepayment penalty income contributed 14 basis points to the current first quarter margin compared to 11 basis points in the trailing 3-month period.

Excluding prepayment penalty income, the net interest margin declined 9 basis points on a linked quarter basis to 2.51%.

Non-interest expenses positively impacted net income this quarter as they declined 1.9% sequentially to $163.8 million, reversing a trend from previous quarters.

The decline was driven by lower compensation and benefits expense and lower occupancy expense, partially offset by a slight increase in general and administrative expenses.

Reflecting our earnings and capital, the Board of Directors last night declared a $0.17 per share dividend for the quarter, representing a 5.1% dividend yield based on last night's closing price.

The dividend will be paid on August 18 to shareholders of record as of August 7, 2017.

On that note, I would now ask the operator to open the line for your questions.

We will do our best to get to all of you within the time remaining, but if we don't, please feel free to call us later today or this week.

Sherry?

(Operator Instructions) Our first question is from Mark Fitzgibbon from Sandler O'Neill.

Of the $1.8 billion pipeline of loans held for investment, what would you estimate the average rate on that is?

So the total coupon that we -- in that portfolio, is about a 3.76%, Mark.

So the new loans you're booking are at rates that are slightly above the portfolio rate.

Is that fair?

Yes, that's right.

The portfolio rate as of the end of the quarter was at 3.52% combined with multi and CRE.

Multi being around a 3.4%, and the CRE book at 3.94%.

So you blend that at 3.52%.

It also -- it looked like the origination, especially finance and CNI loans ramped-up quite a bit this quarter.

Are we likely to see that continue in coming quarters?

I think it's fair to say, Mark, that seasonality, it was strong this quarter, and we expect to see some good growth.

Those are pretty substantial numbers.

But clearly, we are running at a very nice efficiency ratio there in respect to billing the business.

And the business -- the business, as it becomes more seasoned, we're seeing some very attractive opportunities.

And given that these coupons are slightly lower than the multifamily yields, a lot of them are adjustable-rate, probably 2/3 adjustable rate towards building a portfolio that has a positive impact or interest rate sensitivity.

So clearly, we should see some good growth there.

I would say I don't want to be as bullish as far as Q2 versus Q3 in respect to growth in specialty finance.

But I would say, throughout the year, you will have very strong growth quarters there.

Okay.

And then, Tom, how should we be thinking about expense growth for the back half of this year?

So Mark, what I would say to that is, obviously, we have 2 lines of businesses pending a closing of the transaction.

And it's -- overall, there're material expenses associated with those 2 lines of businesses.

So bear in mind that we made the announcement to exit the mortgage banking business.

At the same time, we got approval from the FDIC to exit out of our loss share assets.

Those 2 businesses combined have approximately $60 million of expenses.

The vast majority of those expenses will disappear upon the closing of these 2 transactions.

So clearly, that's going to be a benefit to 2018 depending on the timing of closing.

We expect that the Cerberus transaction should close in very short order, and we should close on the Freedom deal before the end of this quarter.

So collectively, let's say we have a small transitional period of a couple of months in the fourth quarter, come 2018, we could see a substantial expense, say, from exiting these businesses.

And obviously, we'll be receiving cash proceeds for these businesses of approximately $2 billion, combined with the FDIC piece and the sale of the MSR.

There's a lot of overhead with respect to the servicing book as well as dealing with the loss share assets.

So when you look at the benefit of redeployment of $2 billion cash, we estimate that we have to sell 1.45% type reinvestment yields just to break even.

So clearly, if we reinvestment into LCR assets we will save a couple of 100 basis points on there and loan yields of 200 basis points blended, it should be very attractive for an accretable benefit to exit the business.

But more importantly, we are solving the planning for being a SIFI bank without grossing up the balance sheet on LCR.

This is a very substantial LCR benefit given the movement of the securities from held-to-maturity to held for sale and the $2 billion approaches we're getting from these transactions without grossing up the balance sheet.

Great.

And then lastly, and I know it's a very small portfolio, and your credit quality is pristine, but what value have you marked your medallion portfolio down to at this point?

Well, as you know, we've heard the word fluid on many other calls, so it should be an interesting quarter with respect to the medallion activity.

Again, we've been very focused on that.

It's been an ongoing difficult environment.

We have about $134 million on the medallion portfolio principal balance as of June 30.

We have our value that we described to you about -- just about 450-ish, 448 to be precise, and we have about a 10% reserve against that.

I think it's important to note that roughly 70-odd percent of our portfolio is performing, and that performing portfolio is performing at the $600,000 level.

Mark, just one other point to that.

I would blend the taxi medallion that we had 50% (inaudible) 50% single issuance.

So we have a unique portfolio.

It's not all a single issuer.

Our next question is from Ken Zerbe with Morgan Stanley.

Joe, if I heard you right, I think you said you plan to resume organic loan growth starting in the second half, presumably.

Right.

Yes, with the intention of crossing over organically the $50 billion mark.

Although, I know you want to do a deal.

But my question is, if you have -- I think it was $5 billion of sort of growth potential which you could do in the second half.

If you have all that, why not start organic growth earlier?

Like why didn't we add maybe $1 billion of assets this quarter and a little bit less intense growth in the second quarter?

I think as you've seen, there was an awful lot of activity during this quarter.

The ability that we have to do these things prospectively was driven by the activities that occurred during the quarter, so you have a valid point.

All things being equal, we could've done this sooner.

But given where we are, we think that we are well positioned to do up to $5 billion of growth over the period ahead, and that'll work out fine.

And Ken, just bear in mind what Mark said, it is the second half, so we are in the second half.

We are seeing some strong loans, pipeline business.

And we'll prepare to utilize this excess liquidity to move forward and grow the balance sheet both on LCR assets as well as loan growth.

So we're resuming our growth starting the second half, which is July 1.

Got you.

And borrowing -- actually finding a large deal, when do you anticipate at this point crossing over $50 billion on a fourth quarter average basis?

Well, Ken, as you know, there are some advantages to wait towards the end of the year given the nuances on regulatory crossovers.

So obviously, we can buy an extra year of CCAR preparation.

That's always helpful.

So that come October 1, that becomes very beneficial.

But as everybody is aware of, the dialogue in Washington has been fluid.

There's been a lot of interesting proposals presented out there publicly, and we're waiting and seeing.

But in the meantime, we think that we have a lot of room here to resume our growth as we monitor the developments in Washington.

That being said, 2018 could be a reasonable year when we do the crossover.

Also, you should note that in some of the proposals in Washington, those that are already there, stay there.

Those that haven't gotten there get the benefit of the change.

It'd be foolhardy for us to make the change right in front of the change in the law.

Understood.

Okay.

And then just last question in terms of the margin.

Tom, I guess, what drove the margin, the core margin, to be -- I guess, it was down 9 basis points if I heard right, versus your expectations.

And how do you see margin playing out next quarter?

Well, I'm going to be very clear and very detailed.

There're a lot moving parts that are going to happen in Q3, and it's really very short-term notice because we have these large 2 pending transactions.

But going back to the second quarter, we got it down 5%, we're down actually 9x prepay.

Deposits slowed it down 6 basis points.

I'd say the miss was consistent with the home loan banks stock base substantially reduced that dividend.

That cost us 2 basis points, and we had another 0.5 basis point on -- just on loans and borrowings.

So I would say that the -- well, it was not a big surprise, but the adjustment was driven by the home loan bank stock having a substantially lower dividend than the previous quarter.

As far as the guidance going forward, bear in mind, we have 2 pending transactions as I indicated, approximately $1.5 billion of UPB, that we're selling to Cerberus, which has a relatively high yield.

That -- we're getting back on that transaction with the Freedom transaction approximately $2 billion in cash.

So the net effect of that, assuming the reinvestment period is about 15 basis points to the margin down.

However, if you take out the transaction as a whole, you're probably looking at a down 6 basis points quarter because of the increase in rates that happened in June and given where the current portfolio stands today.

My provisional point I was explaining to Mr. Fitzgibbon was that at -- reinvest those proceeds at a 1.45% of rate.

Bear in mind, cash is at 1.25%.

At 1.45% rate, we break even on the transaction.

So clearly, as we deploy the cash into loans, they're probably 200 basis points above that, reinvestment break-even rate and the LCR security is about 100 basis points above that, we believe that we can easily earn back the reinvestment time in a very short period.

Cost savings on the transaction should occur relatively quickly upon the closing of these 2 transactions.

(inaudible) wrong with the handset.

But it's going to be a very, I'll call it, an interesting quarter given a lot of moving parts.

This is not normal activity, yes.

Our next question is from Ebrahim Poonawala from Bank of America.

Just to be clear in terms of just crossing over the $50 billion mark, I know we've talked about it for the last couple of years.

As we think about -- I get that the capacity and if you do it in the fourth quarter or early next year, that pushes out the CCAR cycle for you.

But are you saying that you're okay crossing the $50 billion just getting over that mark even in any one quarter without seeing any legislative action in D.C.?

Yes, I think the important thing to recognize is it's a fluid environment.

And although we could mechanically do things very rapidly, I think we're going to be somewhat cautious as to how we will proceed.

If we had our druthers, the deal that we negotiated to finality with Astoria would've closed and our balance sheet would've been structured perfectly with consolidation.

The reality is that there are uncertainties in the period ahead as to what will be the rules that will govern how we, in particular, will proceed.

So I think we're giving ourselves maximum flexibility.

A couple of quarters that we performed less than we would love to be able to perform is, in fact, just reality.

The balance sheet will change dramatically in the transaction, but we do not determine the actual closing date of a transaction.

There are external factors that are in play and certainly will be very, very meaningful to the consequences of time here.

So I think without being explicit as to what we will actually do, we will react well to the environment as that environment changes.

Understood.

And just very quickly, Tom, so that I understand, is it your intent to start -- already start adding LCR assets?

Or are you creating capacity, keeping that cash on hand and then just -- so you have the flexibility to add on LCR assets when you decide to?

Well, obviously, we're going to be highly dependent upon market positions.

As the release indicated, we saw the $500 million of level 2 assets had a very substantial profit.

So we have the flexibility to continue doing that as we monitor.

We need to get our LCR levels up as we plan to cross over SIFI.

In the meantime, we're going to have a lot of cash to deploy.

Going back to the Astoria transaction, we did not expect the gross of the balance sheet.

This is an alternative of the Astoria transaction without grossing up the balance sheet.

So we're going to deploy assets in the current quarter depending on market conditions for LCR, both level 1 and level 2. Depending on the class of securities, we'll get duration of risk and monitor interest rate sensitivity.

At the same time, we also are going to deploy -- resume our growth on the mortgage portfolio.

We believe that the mortgage portfolio growth is coming.

We think that we're going to have a bigger growth here -- in the second half.

Our growth was relatively slow than we expected in the past few quarters.

When you back out the participation over the past 1.5, we were growing mid-single digits.

So we'd like to get up to the high single digits on that loan growth from multi-family/CRE.

At the same time, we've added $0.5 billion of capital to support that.

In the meantime, we have a lot of abundance of liquidity and a substantial amount of work to do as far as reinvestment.

We're going back to -- our benefit here is that loan yields are probably 200 basis points above this reinvestment target and LCR assets will be about 100.

So either way, we should see some benefit to the earnings power next year as we grow the balance sheet given the balance sheet work that we've done today -- in the past quarter.

That's fair.

And then can you give us a sense of what the amount of LCR from HQLA securities we need to add to the balance sheet?

I'm not going to be specific as far as -- specific as a dollar amount, but I should -- remember, with the Astoria transaction, we're talking about $3 billion to $3.5 billion.

We're smaller now.

We have some movements on our liabilities.

We've moved out certain types of liabilities.

We have less wholesale liabilities today, and we have more maneuvers we can do on the deposit side to offset that actual calculation of 90% and up to 100% over time.

So we have some flexibility.

It's close to what we have in respect to our current portfolio and the cash reinvestment.

But as I indicated, we will be investing some of our cash in our loan growth, and we believe we can resume our loan growth back to the high single digits over time.

Understood.

And just one last follow-up question.

If I heard you correctly, you expect $60 million in annual expenses to come out following the end of this transaction?

What I said specifically was that the 2 businesses themselves have approximately $60 million of cost associated with that.

So assuming that line of cost is exited, that would be approximately a $29 million bogey that we would have to hit for reinvestment.

That's a $145 million on $2 billion of cash, which is very achievable.

We feel highly confident that we should see in 2018 a lower cost structure for the company.

So when you model the company's run rate, we are going to be dealing with the closing of the mortgage business, exiting the FDIC cover loss transaction business as well as cost-containment in general.

With that being said, I don't envision a substantial build of consulting fees and additional SIFI expenses that we've borne in the past 5 or 6 years.

We estimate that we spent over a $150 million getting SIFI-ready.

So you're going to see a natural change in the level of expenses.

Part of this quarter, we had a nice little drop Q1 versus Q2.

We believe that this level is probably going to be around the level that we could run for the rest of the year, around this 163-ish, 164-ish level, then we're going to have the mortgage banking business exiting by year-end and in 2018 those costs should be out of our run rate.

So I think the important thing to recognize here is that the pursuit of our business model of growth by acquisition was discernible with the closing of the Astoria transaction.

Given that that transaction did not close and there is no certainty as to when there would be the closing of any future transaction, the balance sheet is better situated today to perform on a standalone basis.

Our next question is from Christopher Marinac with FIG Partners.

I wanted to ask about prepayments and the visibility for those, the second half of the year.

Do you think they'll be similar than what we saw in the second quarter?

Prepayments are something that over our entire public life we've refrained from trying to get or estimate.

There are many, many different factors that drive the speed with which prepayment occurs and who within the portfolio is prepaying.

As you may have recognized, there is some that have outstanding prepayment fees at 1% and others that have outstanding prepayment fees of 4%.

So who chooses to move and why is going to be the determinant as to the cumulative effect of a given quarter's prepayment.

So it's not something that we're prepared to give you a number on other than the fact that as you know from the facts, and that's what we can really rely on, is there is a significant capacity for us to get prepayment payments.

And certainly, quarter 1 was not as good as quarter 2 and we certainly aren't going to go to a number with regard to 3, 4 and beyond.

So Chris, I would just add to Joe's commentary that Q1 was just under $10 million, Q2 was around $13.2 million.

Those are low numbers given the magnitude of our portfolio.

Every loan that we write has some structure that we get paid on.

So every file that's touched, we have an opportunity to create a fee.

Activity has been generally slow, therefore, you're seeing less prepayment activity.

But typically in our business, the second half is always a robust part of our seasonality.

So assuming that we have an increase in activity, you'll see an increase in prepayment activity.

We're just not going to put a number on it.

That's great.

And just a follow-up on expenses, Tom.

Do you think that the regulatory build-out is largely completed?

Or would you still have additional expenses to bear the second half of the year?

Yes, I'd say largely completed.

We have things to do in general, but there's going to be a lot of moving around of personnel and accommodations.

A lot of heavy lifting was created to get the Astoria deal done and so if you look at the past 1.5 years, our expenses were significant.

When we made the announcement of Astoria and that deal did not close we bore those expenses.

Like I indicated in the previous 2 calls, we still have the remnants of a lot of consultant fees that were embedded in our run rate.

A lot of that is not recurring.

We've got lot of those the nuts and bolts of building that infrastructure.

Now we have to manage the franchise going forward as a much larger institution.

We truly believe that our infrastructure today has an expense base to be a much larger institution as we continue to go through this process of becoming a SIFI bank.

So clearly, we're going to have some reallocation of cost throughout the institution, but I feel highly confident that we're not going to have substantial expenses going forward.

At the same time, as I gave guidance, I'll give guidance for Q3, we're going to be around 164-ish, pretty much consistent with Q2 levels as we continue to look at cost containment velocity throughout the bank because we spent a lot of money on getting ready to close the Astoria deal as a SIFI bank.

So I think going forward, when we look at the mortgage banking exit, that's a substantial amount of cost structure that we have to deal with.

That's not -- we don't have a $21 billion servicing portfolio anymore.

There're a lot of bodies that can get involved with new management with assets.

We're not out there representing (inaudible) throughout the country as Freedom is buying that business.

So we have a sizable amount of expense that will be not part of our infrastructure in 2018.

We hope to do it sooner rather than later, but it's going to be a small transition period.

So assuming everything closes by September 30, Q4 should be -- you'll see some notable changes.

And then going into '18, we should be able to wring out all those costs to manage the business.

Our next question is from Collyn Gilbert with KBW.

Okay.

So Tom, I'm confused.

I apologize, but I'm just trying to understand.

Let's start with the impact of what's going to happen next quarter.

So I know you're saying you're talking about the cash yield, a little bit of pickup.

But at the end of the day, those mortgage loans that you guys moved for held for sale, that moved late in the quarter, right?

So I...

No, they haven't moved yet, right?

So right now, we're pending a transaction, right?

And we have 2 transactions that are pending.

One with Freedom, one with Cerberus.

As we close those transactions, they will result in substantial cash proceeds for the bank.

Those proceeds will have to be reinvested.

So when we talked about the margin, in the third quarter it's going to be very volatile given that we're going to be sitting on cash until we redeploy, depending on the closing of those transactions.

We believe the Cerberus deal will close before the Freedom deal, and then the Freedom will probably close towards the end of the quarter.

Collectively, we have to reinvest approximately $2 billion of cash from these transactions.

What my point was is that if we sit in cash at 1.25%, it'll pretty much offset the revenue affiliated with those 2 businesses.

The break on that number, the reinvestment break even, is the 1.45%.

If we were to put some money into LCR assets up 100 from there and into loan which was up 200 from there, you can see where the math starts to get you to an accretive transaction by exiting the business, assuming you wring out the cost structure.

Okay.

So the -- right.

So the higher yield, but then you're talking about the funding that you need.

So you're getting rid of -- taking that out -- completely off the balance sheet, which is why you can then afford to invest in a lower -- a lower...

Well, again, we're going to be sitting -- once we get the cash, we'll have cash to reinvest.

As we indicated, we are not -- what's interesting about these transactions as well as our balance sheet, when you move on held to maturity to AFS, now instead of grossing up our balance sheet to solve for LCR, we have proceeds within the portfolio to solve for LCR and resume our growth in our portfolio.

But I guess -- right, which is helpful.

But ultimately -- and I guess, what I'm getting at is just kind of where the trajectory of the NIM is going to go here a little bit longer term, which I'm curious on the funding side as well.

But I mean, at the end of day, you're still taking off assets that generate a 3.5% yield that you're replacing at a 1.5% yield?

No.

Not something I've said.

No, no.

I'm saying that we're going to be taking off assets temporarily at a mid-3% yield, and we plan on replacing it with multifamily and CRE assets as well as LCR assets.

So blended, okay, blended, we can clearly absorb the impact of the exit of that top line revenue adjustment to expense savings, the expenses to these businesses.

Remember, these businesses are high-expense businesses.

We service $21 billion of UPB for residential loans.

That's going away, so it's a substantial expense reduction program to deal with the exit of these 2 lines of businesses.

At the same time, so -- but I just want to be clear, the third quarter margin will be temporarily adjusted because of these actions, but you'll see resumption very quickly assuming we put the cash to work.

It could happen as early as the fourth quarter.

I think it's important to note that cash gives us great discretion as to how we're going to actually use it.

We could in fact, upsize the company and acquire assets or we could leave the company without upsizing and merely pay off higher cost liabilities, and then that doesn't grow the company.

So this is a great deal of flexibility based on the future environment for us to pursue.

And Collyn, assuming that we did not do these transactions, I would guide the margin down for Q3 by 6 basis points, solely driven by the issue of the additional rate hike that happened in June.

So this -- that leads to my next question then.

So what is your outlook for funding of the pro forma balance sheet?

I mean, where do you think funding cost ultimately will go or how we should think about that?

And then the other question is on sort of capital and where you see capital ratios migrating, again, beyond what's happening in the third quarter, but just a little bit more longer term.

Collyn, I never give guidance actually a quarter out.

I'm not prepared to give cash out, but I'll give generalizations of scenarios.

And obviously, if the Fed's done raising interest rates, the margin should start to go up.

If the Fed continues to put on an aggressive stance of raising short-term interest rates, we'll have further pressure.

We are modeling internally another rate hike at the end of the year.

And again, it's not going to be cataclysmic to us, we'll deal with it.

As far as capital is concerned, our capital ratios are very strong.

Risk-based capital at 13.11%.

Our total risk-based capital base at Tier 1 risk-based at 13.11%.

Total risk-based at 13.52%.

We feel very good about our capital position given that we raised $0.5 billion of preferred the previous quarter.

So we feel very good about our positioning capital, our asset quality and our position to leverage that capital to grow the balance sheet.

So are you -- I mean -- so if we're -- I think probably, right.

The earnings are going to settle at a much lower rate, right, which is going to pressure the internal capital generation capability.

Again, I'm not going to concede to that statement because obviously I don't give out a year -- solid guidance.

But clearly, as the balance sheet starts to grow and the yield curve starts to cooperate, we hope that we start seeing growth in 2018.

We -- again, we know we have a very strong Q3 with respect to a $90 million pretax gain coming to the quarter, so capital will grow in Q3 from the gain of the sale of these transactions.

Q4 will be the quarter that we transition the expenses, and in 2018 we'll have a much lower expense run rate for the company and a substantial amount of reinvestment power and asset growth power for 2018.

We're looking at a future period with more flexibility than we normally would have absent the closing of a deal.

Now closing the deal gives us greater flexibility.

So based on what we've already done here, the balance sheet restructuring we've already done, we have a great deal of flexibility going into the period ahead.

Okay.

One final question, sorry.

Just then on -- through all this, the provision.

Obviously credit is impeccable.

Where do you guys see the provision sort of trending as we look out and the need to build that?

Well Collyn, like I said before in the past 2 or 3 quarters, the difficulty in asset quality has solely had been in the medallion portfolio.

We deal with that as we move along.

We evaluate that every quarter.

We feel that that area is still under pressure.

We have about $134 million, so it's insignificant to our $50 billion balance sheet, and that's where the provisions will continue.

This was, I think, an outside provision -- an outsized provision in Q2.

I don't envision those types of provisions going forward but it's possible as we monitor the medallion portfolio.

But after that, the portfolio is performing at -- it's stellar, 0 charge-offs in all other lines of businesses.

We're very comfortable with the asset quality metrics.

The performance has been phenomenal in respect to the line of business that we plan, which is rent regulated and multi-family cash flows.

And I don't envision any significant reserve that will be close to that line of business.

Our next question is from Matthew Breese with Piper Jaffray.

Just considering your outlook for the next year and resuming high single-digit loan growth in multifamily and commercial real estate, just thinking about the securities portfolio and what's going to be put on there.

Maybe trying it this way, as a percentage of total assets, securities are quite low relative to some of your peers.

Where do you see that going out?

Yes, so it's been the lowest since our public company.

We've been using that rationale to manage the SIFI threshold.

As we get past that philosophy, you will have you have to normalize the portfolio through LCR requirements and just general corporate purposes.

So I'm not going to give a specific number, but we're not going to run at 6%.

So we're at a very low level right now, the lowest since the company went public.

This is a very small amount of securities we'd have to rebuild over time, predominantly to softer LCR.

In addition, we have a tremendous opportunity here assuming that in the event we do get a sloping curve, to hopefully reinvest in higher yield.

We're going to be very careful on that growth with respect to market conditions.

Yes, I think it's important to note that deal or no deal, it has a great deal of relevance as to both SIFI as well as what the balance sheet will look like, and that's out there on the horizon.

It's something that needs to be addressed.

Okay.

But conceptually speaking, you think that 6% is going to something higher, whatever that higher number is?

Yes.

Oh yes, yes, yes.

Mathematically, it has to be.

So obviously, if you look at the track record in the past 3 to 4 years, since actually 2013, it's been our strategy to utilize the excess cash flows from the securities portfolio as the means of not selling other assets to stay below $50 billion.

So for example, on a higher debenture portfolio, we got paid off when the rates went dramatically lower.

So what we have right now is a substantial portfolio of DUS bonds, which happens to be a very attractive portfolio, but they have very attractive characteristics as far prepayment is concerned.

But we then -- we will look at LCR1 assets as well as a combination of different type of LCR2 assets as we solve for our requirements as a SIFI institution going forward.

Okay.

And then drawing it out over the next year, as you guys resume growth, cross the $50 billion, if by that point at the end of the year nothing is changed, there's no deal, there's no change in the $50 billion threshold, what's the strategy at that point?

Could you -- do you pull back the size of the balance sheet?

Or do you consider other things like corporate structure and getting rid of the hold code across organically?

Yes.

I think the important thing to note is that there'll be a great deal of flexibility as to what we might do.

And certainly, the environment would be very contributory to the decision process.

So if we were to believe that we were in close proximity to executing on a deal, everything would be structured toward that.

If we were to believe that there would be no possibility of a deal, we would be doing very different things.

So I think what you see here today is a balance sheet restructuring that is meaningful, that gives us a great deal of flexibility for the period ahead.

When I say period ahead, for the year ahead.

It's not just some quarter or 2, it's for the year ahead.

And over the course of that year, there'll be many things that happen away from us that will govern how we can reasonably expect to proceed, and there'll be many things that happen either within the company or with regard to opportunities presented to the company that would likewise give us a reason to actually execute on an earlier date than a protracted period of just restructuring our balance sheet.

The important thing here is we've taken overt steps to put ourselves in the best possible position to make choices in the period ahead.

And I will just add to Joe's commentary that obviously, we spent a considerable amount of time gearing up for the Astoria transaction.

That did not happen, it was terminated.

Moving forward, we look at all options on the table.

And clearly, anything that makes logical sense for our shareholders is the priority.

We will look at all our options as we move forward here.

Clearly, resumption of growth is the first option that we've been waiting for, for quite some time.

And the fact that we did not execute on Astoria, we need to move forward, and all options are on the table.

Okay.

And then maybe just on the M&A front.

With the Astoria deal not occurring, could you just give us an update of the types of deal you want to do or would like to do, the geographies, or is that kind of a deal smaller or larger than Astoria?

Could you give us a little bit of color there?

I think broad -- yes, broad brush, unless there are material changes in the valuation of the company from other reasons, I would suggest to you that we would do a smaller rather than a larger deal, given the positioning of our currency, but that should be evolving.

So without being overly specific, we are going to consider the environment in which we make a decision that will be meaningful to the future of the company.

And therefore, the size is relevant.

The location is not necessarily relevant.

We can do highly accretive deals as evidenced by, for example, the AmTrust deal, highly accretive deals in difficult markets.

The asset markets that we, in fact, entered were in devastation.

We didn't do assets in those markets.

We didn't get assets from those markets.

We, in fact, entered those markets and have very successfully had the ongoing business on the deposit side, that has done extraordinary well.

So there is no limitation as to where we might go.

There are many, many attributes of in-market deals, and then again, there are other attributes that exist in out-of-market deals.

Pricing is important.

The various other attributes of the ongoing business is important.

The assets to be disposed of at what value, is important.

So there are many, many considerations.

So I would not say that there is a locked in expectation that we're going to move forward with a deal in Indiana.

We're not.

We're going to move forward with the best possible opportunity when that opportunity has a high certainty of completion, and that's the important thing.

We negotiated a fully-completed deal with Astoria, but the environment did not allow for us to close Astoria.

We need to be in a place prospectively where there is a reasonable expectation based upon all that can be known at the time that we execute, that we can reasonably expect to close.

The deal was fully negotiated and legally closed.

Shareholders approved the deal.

So the future is uncertain with regard to timing, and there are going to be things that happen over the period ahead that will give us some clarity as to what the environment presents.

Understood.

But in terms of the way you say smaller versus larger, could you just give an idea of how small that you would go?

Would it be...

Yes, I mean, yes...

So Matt, it's Tom.

I think what -- to think more to his point is we have a currency that's nowhere near where it was 1.5 year ago.

So we've done deals and stopped transactions by utilizing a very attractive price to tangible book multiple.

So obviously, as that multiple has come down considerably, we have to evaluate the use of currency.

At the same time, when you look at the benefits where we are with respect to the rate environment and the shape of the curve, we have a very high-cost structure and our cost of funds that any deposit deal of any reasonable size will have significant benefits towards lowering our cost of funds.

Our cost of funds are way too high.

Typically, the company is not as competitive in the deposit market because we've always had a transaction that's been pending that move the bar for us in respect of funding balance sheet.

So clearly, what we have -- we hear any substantial deposit base, anywhere from $3 billion to $8 billion type deposit base, will have a meaningful impact to the bottom line.

The challenge is that our currency multiple on tangible book has come down considerably.

Therefore, doing a very large transaction at a very little price is difficult to achieve given the current valuation of the stock.

I think you can appreciate the fact that the relationship between our currency and the target is relevant.

Now could there be a target that has a currency that's actually performing worse than ours?

It's conceivable.

And the future period, 6 months, 9 months down the road, who knows?

The future period may present that kind of opportunity.

So there is no way to know what that will be, accepting that we will smartly look at every opportunity as presented and make the choice which should have the best outcome.

Understood.

My last one is just with the exit of the mortgage business in Ohio from the AmTrust acquisition.

What is the strategy now in Ohio with what's left there?

Obviously, we have other -- we have real estate out there, we have other operations, we have other -- risk people out there, we have quite a few tech people that we have in place there.

Reality is that we will have a plan in the future which we'll announce to the marketplace on how we handle the exit of this business.

Obviously, Freedom Mortgage we look at as a partnership.

We hope to continue the partnership in all respects as far as providing credit to our customers in a way.

As far as the overall business model, we have a sizable deposit base in Ohio.

We have real operations in Ohio.

We have real operations in Arizona and substantial operations in Florida.

We're not exiting Ohio, we're just exiting the mortgage banking business, which is really a wholesale corresponding business.

When we did that transaction, we had no intention of keeping the mortgage business.

That decision was made 6 months after the close of the transaction.

So the deposit base in Ohio and the businesses that we do in Ohio are very consistent, and likewise, they have proven themselves to be viable.

So we're very pleased with our franchise in Ohio, and we have no intention of changing that.

Our next question is from Peter Winter with Wedbush Securities.

Can I just get some clarification on the core margin for the third quarter or so?

If I heard you right, the June rate hike is 6 basis points, and then the transactions that you're doing on the mortgage side is another 15 basis points, so the core margin is down.

No, no, no.

Let's be clear.

Assuming we didn't have -- no transaction existed, we would be down -- I'd be guiding down 6 for Q3.

Now that we have the transaction and we expect to close the transaction within the quarter, Cerberus will close first, Freedom will close second, the impact of the actual transactions impacting our margin will be around 15 basis points.

That is a temporary adjustment to the margins.

We're going to be sitting on $2 billion in cash.

We're not going to be sitting on $2 billion in cash for the next 18 months.

Our goal here is to resume growth in the balance sheet, growth in LCR assets.

And you'll see asset growth, loan growth and clearly security growth at a higher yield than cash.

The cash level of the current market is 1.25%.

By reinvestment and break even on that $2 billion to 1.45% to offset any negative impact for the exiting businesses, we believe that we can pick up 100 basis points in LCR assets off that 1.45% and another 100 basis on top of that for loans, let's say 3.50% billion to 3.65% on being conservative.

So clearly, the opportunity as we wring out the cost structure from these lines of businesses, that will add earnings power as a result of the exit of these businesses in 2018.

But with the timing difference -- I'm just thinking about the core margin in the third quarter, what would be the impact in the third quarter from the sale?

The total impact will be 15, 6 basis points from normal operations and another 9 basis points from the actual $2 billion of low yields.

Got it.

Got it.

And then secondly, I'm just wondering if you can talk about the loan demand, where you expect it to pick up just given -- there's still uncertainty about the tax reform, and we're still in an environment where rates are kind of low so it doesn't create a lot of refi activity.

I think the good news is that the way we've positioned ourselves in this particular niche is extraordinarily important to the share of the niche that we wind up getting.

So whatever the consequence of external factors may be, the change in our position will be driven by how we position ourselves against the competition.

So I think the important message here is that even in the slowing environment, we've had occasion to grow our loan book through a devastating period, and I'm not anticipating a devastating period in the immediate future.

So we have the flexibility to grow and have the tools to grow our loan book in the period ahead.

And Peter, we've been very careful on managing a SIFI threshold.

As you know, we sold close to $5 billion of assets over the past few years.

Those are multi-family CRE assets that are high-quality assets.

We're selling less now.

Going forward into this second half of the year it's typically the seasonality benefit of the multifamily business in the New York City marketplace.

We believe that -- so if there is less prepayment activity, that means there'll be more asset growth.

So we feel pretty confident that the pipeline is building very nicely into the summer.

We will be very active in the marketplace.

We are the #1 portfolio lender of these types of assets, and we will be in the marketplace in the second half.

Another thing to note there is that that $5 billion represents to us an opportunity to refi, and low and behold, it's not evident in the size of our balance sheet, but it's evident in our presence in the market.

So I think there's more opportunity there than people realize because that segment is all 100% re-financeable with us.

We don't have to participate the refinancing of the asset.

Got it.

And just one last question just on the deposit side.

New York Community has always maintained a high loan-to-deposit ratio, and I'm just wondering if there's a strategy or a thought in place to put more focus on deposit growth.

Or do you kind of solve the problem?

You mentioned earlier about maybe doing a smaller acquisition.

And would that make the deposit...

So Peter, obviously, this is a unique time for us.

We've always been an acquirer of liabilities.

For the first time in our public life, we've been active in the market, obtaining interest rates that are at the market and not below the market.

So we are maintaining our deposit base based on our liquidity needs and the size of the balance sheet.

As we grow, the goal is to bring in deposits.

As you know, since the crisis, there has been an economic change between wholesale funding and deposit funding.

That economic changes about 18 basis points to the company.

So as we have less wholesale liability, the company becomes more profitable, if we can match fund that with operating expenses going down, we're not spending FDIC assessment on the wholesale leverage position.

So clearly, it's been a strategy change because the acquisitions have not happened for the company in quite some time.

That could shift if we do a transaction, obviously.

But in the meantime we will have to run the bank.

Importantly to note, Peter, 2009 was the last time we did a meaningful transaction.

From there to today, that is a very, very long time for us.

So we are very anxious to do a highly beneficial transaction at the earliest possible date.

As I said previously Pete, we have a very high cost of fund structure, and it's not typical for us.

So obviously, if we were to look at the opportunity there, any deposit base coming into the franchise, more likely than not, we'll have a lower cost of funds which will benefit the bottom line for the company.

Ladies and gentlemen, we have reached the end of the question-and-answer session.

I would like to turn the call back to management for closing remarks.

Thank you again for taking the time to join us this morning.

We look forward to chatting with you again during the last week of October when we will discuss our performance for the 3 months ending September 30.

Thank you.

This concludes today's conference.

You may disconnect your lines at this time, and thank you for your participation.